Thu, 21 Jun 2012
Amid fears of long-term global systemic risk, investors are seeking to park cash in conservative vehicles that offer wealth preservation, income generation, and limited NAV volatility, says Fidelity's Bob Brown.
Christopher Davis: Hello, I'm Christopher Davis, a senior mutual fund analyst with Morningstar, and I'm also lead analyst at Morningstar covering Fidelity Investments. I'm here at the Morningstar Investment Conference with Bob Brown. Bob is the relatively newly appointed head of Fidelity's bond group. Previously, he lead Fidelity's money market group, so he's well equipped to share with us his thoughts on cash, the safety of cash, and how you can get income in this really challenging environment. Thanks for joining us Bob.
Bob Brown: Thank you, Chris.
Davis: Well, my first question just surrounds the conundrum that investors really face. A lot of income-oriented investors need income, but they also want safety.
Davis: And presumably what we think of as safe investments have almost no yield. So how do you balance those two competing pressures, getting yield and not losing your shirt?
Brown: So I'd like to set the context. If you go back to prior to the last real credit crisis in 2007-2008 for United States, cash to me was a vehicle that was essentially an on-ramp into bond funds and equity funds where investors would use it almost as a safe parking spot and then move into the strategic allocation of their portfolio, their wealth creation.
Post the 2007-2008 crisis, and then if you layer on what's going on in the Europe, investors are now looking for, from our perspective, a safety net, if you will, in terms of principal preservation. I think it's gone from being an instrument or a vehicle to move you into either equity or bond 40 Act funds, to a core part of a strategic portfolio in a world where systemic tail risk is probably going to be with us for yours and my careers, and it's not going to go away anytime soon.
As a result of that, I think operating cash would be in the money market side, and then you have this, what I call stratification of strategic cash. So liquidating investors are adapting to the economic and marketplace changes by expanding their toolkit as it relates to their allocation to cash, and for me, that move into strategic cash, a move out of money funds into bond funds is really centered on the premise of income generation, wealth preservation, and limited net asset value volatility. These are bond funds, but they are conservatively managed in terms of the assets, the sectors that they invest in, and individual securities.
So from Fidelity's perspective, what would a shareholder expect to see in a fund named the conservative income bond fund? They wouldn't expect to see structured securities in there. They wouldn't expect to see a high-level allocation to BBB securities, and that's not what you have. We have a robust high-quality investment-grade portfolio. There's a limited allocation to BBBs, and it's generating a nice level of income for our shareholders, again with those tenets of income generation, wealth preservation, and limited NAV volatility.
Davis: I think in the runup to the financial crisis, a lot of investors use ultra short-term bond funds, sort of as a way to park their cash and just get a little bit more yield. But in some very high-profile instances, shareholders were really hurt. Charles Schwab's ultrashort fund was down 30%, and so there was terrible capital preservation there. If you invest in an ultra-short or short-term bond fund today, are you getting the same kind of product you did that way back then?
Brown: So I'll comment on the fund that we launched in March of 2011, the Conservative Income Bond fund. We are restricting the level of BBB securities to around 5%. There are no structured products, so for a lot of the securities that created a massive amount of issues for the enhanced cash funds during the time period you talked about, the fund is limited from owning structured securities. It is really about true high-quality securities that our research team picks, and it really gets back to what would shareholders expect in this type of a fund. They would expect a conservative positioning, there's full transparency on it, and we are managing it for a limited NAV volatility. It is a bond fund, it's not a money market fund, but one of the true tenets of this fund, in addition to income generation and wealth preservation, is NAV volatility.
So through the fund's inception, the low point of NAV is 9.97% and it's currently trading I think 10.01%, and we've been through quite a number of credit events since its launch. With the technical default on the U.S. debt, the downgrade of the United States itself, and the eurozone crisis from sovereign banking, we've been through a number of periods of volatility, and the NAV has been limited in terms of its movement.
From an investment philosophy perspective, it has the hallmarks of a very conservative investment strategy which is consistent with a money market fund, but it is definitely a bond fund.
Davis: I mean you got a little bit of volatility in NAV.
Brown: Yes, so a little bit, but again, think about it. Money market funds, because of the changes that were implemented in May of 2010, are limited in terms of having a duration-weighted average maturity of 60 days. That means by mathematical equations, that approximately 50% of your fund has to be within 30 days to get to the duration-weighted average.
So the opportunity for significant yield, particularly given where the Federal Reserve has pegged federal-funds rate at 0-0.25% through the end of 2014, is challenging. What this is doing is looking at, if you look at the T-bills curve and if you look at the LIBOR curve, there's a steepness in the LIBOR curve six months and out relative to the T-bills curve, and that's the area of the marketplace that we're going after with conservative investments. We've been able to drill down into that sector with the appropriate allocation to sectors and to securities and to deliver a portfolio that our retail shareholders would expect.